As the House and Senate publicly iron out their differences on Wall Street reform during conference committee, the most important aspect of the overhaul is gaining strength behind the scenes. Sen. Blanche Lincoln, D-Ark., is standing firm on her tough derivatives bill, and continues to garner unlikely allies from within the Federal Reserve as the final vote on the provision approaches.

The latest high-profile supporter of Lincoln’s bill is St. Louis Fed President James Bullard, according to a Senate source familiar with the matter. Bullard joins Kansas City Fed President Thomas Hoenig and Dallas Fed President Richard Fisher as recent co-supporters of the measure to rein in megabank derivatives operations. Other key members of the conference committee, including House Agriculture Committee Chair Collin Peterson, D-N.D., are also offering support for the provision, which is likely to come up for a vote next week.

Both the bank lobby and reformists recognize that Lincoln’s effort—known on Capitol Hill as Section 716—is the most serious proposal to rein in Wall Street still on the table for 2010. The bill’s strategy is simple: End taxpayer subsidies for the derivatives market—the crazy casino that brought down AIG, Enron and Long-Term Capital Management. Right now, five megabanks score enormous profits by backing their derivatives operations with cheap loans from the Fed’s discount window and taxpayer-guaranteed deposits. This cheap funding makes derivatives enormously profitable, and encourages banks to fuel enormous speculative casinos. Speculation on that magnitude is inherently unstable, and when the casino comes crashing down, the result is a disaster for the global economy (think AIG and Lehman Brothers).

By forcing banks to move their derivatives dealing into separately capitalized subsidiaries with no access to taxpayer perks, the business would become less profitable, and the global capital markets casino would shrink, putting the broader economy on stable footing.

But since those taxpayer subsidies mean big profits for banks, they also mean big bonuses for bank executives. And so every Wall Street lobbyist in Washington has been targeting Section 716, and they’ve convinced some top-level, bank-friendly officials like Fed Chairman Ben Bernanke and Treasury Secretary Timothy Geithner to defend them.

But lately the political wind has shifted to Lincoln’s back. Former Fed Chairman Paul Volcker, previously an opponent of the provision, reversed his opposition, saying he hadn’t fully understood the details of the plan. A host of high-profile economists, including Nobel Laureate Joseph Stiglitz, former IMF Chief Economist Simon Johnson, Nouriel Roubini, Robert Johnson, Jane D’Arista and others have endorsed 716, saying that it’s the last best chance to end Wall Street’s reliance on taxpayer bailouts.

Derivatives are the central way that megabanks make themselves too-big-to-fail. By engaging in hundreds of millions of dollars worth of derivatives trades every day, banks enshroud themselves in complex webs of debt that no regulator can decipher. If a bank like that finds itself on the verge of collapse, regulators simply cannot predict what will happen if the bank is shut down. The Wall Street reform bill includes expanded authorities for regulators to shut down failing financial titans—but regulators will not use those powers on banks that run derivatives casinos on the scale of those currently in existence, in which five banks control nearly $300 trillion in trading. That’s trillion, with a ‘t.’

Lincoln made a few concessions earlier this week in an effort to appease critics, but so far, none of them have been important. The most significant move will allow the Fed to provide derivatives dealers with emergency funding in the event of a financial collapse—powers known in Washington as 13(3) authorities. For many reform advocates, this looked sinister—the point of the Lincoln language is to remove taxpayer subsidies, but Lincoln would now permit emergency Fed loans.

This is ultimately a non-issue. The point of 716 is to end the situation in which banks fund derivatives operations with loans from the Federal Reserve’s discount window and cheap taxpayer-backed deposits. Discount window lending is radically different from the kind of lending the Fed does under 13(3). Banks go to the discount window all the time for loans as part of the ordinary course of business, and those loans come with a low, predictable interest rate (currently 0 percent). Lending under 13(3), by contrast, comes with hefty and unpredictable strings attached. For all the faults of the Fed’s handling of the AIG bailout, the Fed received an 80 percent stake in the company and discharged the firm’s CEO.

This is not the sort of help that derivatives dealers want from the government—what they want are low-interest-rate loans from the Fed, and cheap FDIC-insured deposits. The prospect of emergency Fed lending doesn’t change the incentives for a derivatives dealer any more than the prospect of some future Congress enacting a new law authorizing broad bailouts of derivatives dealers does.

Without access to discount window loans or FDIC-insured deposits, banks simply cannot operate. Even with access to emergency Fed lending, banks will have no choice but to move their derivatives dealing operations into an independently capitalized subsidiary, and that subsidiary will not be able to fund derivatives with cheap taxpayer guarantees as part of the basic business model. As soon as those operations are pushed out, banks will immediately have to put more capital behind them, and the entire derivatives casino will shrink. The reform is still fully intact.

No law can ban future bailouts, whether they be from the Fed or Congress. When the next financial crisis hits, policymakers will bail out whatever firms they deem necessary to prevent a collapse. If they need to change the law, they’ll go to Congress. If Congress spurns them, policymakers will conduct their bailouts under-the-table by letting firms get away with overly optimistic accounting. What we can do is limit the potential for that next crisis to ever come about. Right now, 716 is the most important provision for preventing a future crisis in the Wall Street reform legislation.

The fight for 716 is by no means over. The endorsement of three Fed presidents comes as a coalition of Wall Street-friendly New Democrats, led by Reps. Melissa Bean, D-Ill., Joe Crowley, D-N.Y., and Jim Himes, D-Conn., push back against the Lincoln language. The New Dems argue that 716 can be replaced by a strong Volcker Rule, which bans speculative gambling by commercial banks. The argument is totally disingenuous—716 is about limiting speculation throughout the financial sector, not just in banks themselves.

So far, neither Treasury nor the New Dems have had much luck persuading members of the conference committee to buck 716. Almost nobody in Washington wants to be caught committing an epic sell-out to Wall Street during the final stages of the reform process, when the public is watching every move. The political momentum is with Lincoln. We’ve known for several weeks that some version of Wall Street reform would ultimately pass Congress. If Lincoln holds firm, that reform will actually be significant.

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